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IRS Modifies Interim Guidance on Amortization of Research Expenditures

(Parker Tax Publishing January 2024)

The IRS issued a notice that clarifies and modifies Notice 2023-63, which provided interim guidance on the amortization of specified research or experimental (SRE) expenditures under Code Sec. 174, as amended by the Tax Cuts and Jobs Act, and provided interim guidance that taxpayers may rely on until the publication of proposed regulations. The IRS also issued a procedure that modifies Rev. Proc. 2023-24 to provide updated procedures for obtaining automatic consent to change methods of accounting in reliance on the interim guidance provided in Notice 2023-63, as modified by Notice 2024-12. Notice 2024-12; Rev. Proc. 2024-9.

Background

Former Code Sec. 174 allowed taxpayers to deduct research or experimental expenditures paid or incurred in connection with a trade or business as current expenses, to capitalize and amortize such expenditures over a period of not less than 60 months, or to charge such expenditures to capital account.

Section 13206(a) of the Tax Cuts and Jobs Act (TCJA) amended former Code Sec. 174 for amounts paid or incurred in tax years beginning after December 31, 2021. Code Sec. 174(a)(1) disallows deductions for amounts that meet the definition of SRE expenditures under Code Sec. 174(b), except as provided in Code Sec. 174(a)(2). Code Sec. 174(a)(2) requires taxpayers to charge SRE expenditures to capital account and allows amortization deductions of such capitalized expenditures ratably over a 5-year period in the case of SRE expenditures attributable to domestic research, or a 15-year period in the case of SRE expenditures attributable to foreign research, beginning with the midpoint of the tax year in which such expenditures are paid or incurred.

In September 2023, the IRS announced in Notice 2023-63 that it intends to issue forthcoming proposed regulations addressing (1) the capitalization and amortization of SRE expenditures under Code Sec. 174, (2) the treatment of SRE expenditures under Code Sec. 460, and (3) the application of Code Sec. 482 to cost sharing arrangements involving SRE expenditures. Notice 2023-63 provided interim guidance upon which taxpayers may rely until the forthcoming proposed regulations are published, including a rule providing that SRE expenditures must be treated consistently for income tax purposes and therefore may not, for example, be treated as ordinary and necessary expenses under Code Sec. 162.

Section 10.01 of Notice 2023-63 provides that taxpayers may rely on the rules described in Sections 3 through 9 of Notice 2023-63 prior to the publication date of the forthcoming proposed regulations in the Federal Register for expenditures paid or incurred in tax years beginning after December 31, 2021, provided the taxpayer relies on all the rules described in Sections 3 through 9 of Notice 2023-63 and applies them in a consistent manner. Section 10.01 also provides that taxpayers may not rely on the rules described in Section 7 of Notice 2023-63 regarding the treatment of SRE expenditures paid or incurred with respect to property that is contributed to, distributed from, or transferred from a partnership.

Notice 2024-12

On December 22, the IRS issued Notice 2024-12, which clarifies and modifies Notice 2023-63 regarding (1) the treatment of costs paid or incurred by a research provider for research performed under contract, (2) the requirement that a taxpayer that chooses to rely on any of the rules described in Notice 2023-63 must rely on all the rules described in Sections 3 through 9 of Notice 2023-63, and (3) the obsoletion of Section 5 of Rev. Proc. 2000-50.

Research Performed Under Contract

Section 6.04 of Notice 2023-63 provides rules for the treatment of costs paid or incurred by a research provider. Section 6.04 provides that if the research provider bears financial risk under the terms of the contract with the research recipient, then costs paid or incurred by the research provider that are incident to the SRE activities (as described in Section 4.03 of Notice 2023-63) performed by the research provider under the contract are SRE expenditures. Section 6.04 also provides that even if the research provider does not bear financial risk under the terms of the contract with the research recipient, if the research provider has an "SRE product right" (that is, a right to use any resulting SRE product in a trade or business of the research provider or otherwise exploit any resulting SRE product through sale, lease, or license), then costs paid or incurred by the research provider that are incident to the SRE activities performed by the research provider under the contract are SRE expenditures of the research provider for which no deduction is allowed except as provided in Code Sec. 174(a)(2). This is the case regardless of whether the research recipient's costs are required to be treated as SRE expenditures under Section 6.03 of Notice 2023-63. Lastly, Section 6.04 provides that a research provider will not be treated as having an SRE product right if such right is available to the research provider only upon obtaining approval from another party to the research arrangement that is not related to the research provider within the meaning of Code Sec. 267 or Code Sec. 707.

According to the IRS, Section 6.04 of Notice 2023-63 could be interpreted to require a research provider that does not bear financial risk under the terms of the contract with the research recipient to improperly treat as SRE expenditures the costs paid or incurred by the research provider to perform SRE activities on behalf of the research recipient under such contract if the research provider obtains an SRE product right that (1) is separately bargained for (that is, an SRE product right that arose from consideration other than the cost paid or incurred by the research provider to perform SRE activities under that contract) or (2) was acquired for the limited purpose of performing SRE activities under that contract or another contract with the research recipient. Consistent with the intent of Section 6.04 of Notice 2023-63, Section 3 of Notice 2024-12 clarifies that if a research provider that does not bear financial risk under the terms of the contract with the research recipient obtains an "excluded SRE product right" (that is, an SRE product right described in Section 2.04(3) of Notice 2024-12) but does not obtain any other SRE product right under the terms of such contract, then the costs paid or incurred by the research provider to perform SRE activities on behalf of the research recipient under such contract are not SRE expenditures.

Reliance Requirement

In Notice 2024-12, the IRS stated that it is aware of situations in which a taxpayer that intends to consistently rely on all the rules described in Sections 3 through 9 of Notice 2023-63 for expenditures paid or incurred in tax years beginning after December 31, 2021, may be required to amend a tax return that was filed before or shortly after Notice 2023-63 was issued to do so. This is because the taxpayer may not be able to change, through a change in method of accounting, certain positions taken on such return that were inconsistent with certain sections of Notice 2023-63. To facilitate reliance on the rules described in Notice 2023-63 in a more administrable manner, Section 4 of Notice 2024-12 modifies Section 10.01 of Notice 2023-63 to remove the requirement that a taxpayer must rely on all the rules described in Sections 3 through 9 of the notice if it chooses to rely on any of the rules described in Sections 3 through 9 of Notice 2024-12.

In addition, the IRS stated that it is aware of situations in which a taxpayer that intends to consistently rely on all the rules described in Sections 3 through 9 of Notice 2023-63 for expenditures paid or incurred in tax years beginning after December 31, 2021, may be required to amend a tax return that was filed before or shortly after Notice 2023-63 was issued to do so. This is because the taxpayer may not be able to change, through a change in method of accounting, certain positions taken on such return that were inconsistent with certain sections of Notice 2023-63. To facilitate reliance on the rules described in Notice 2023-63 in a more administrable manner, Section 4 of Notice 2024-12 modifies Section 10.01 of Notice 2023-63 to remove the requirement that a taxpayer must rely on all the rules described in Sections 3 through 9 of Notice 2023-63 if it chooses to rely on any of the rules described in Sections 3 through 9 of Notice 2023-63.

Obsoletion of Section 5 of Rev. Proc. 2000-50

Section 12 of Notice 2023-63 provides that, as a result of the TCJA amendments to Code Sec. 174 and the rules described in Sections 3 through 5 of Notice 2023-63, Section 5 of Rev. Proc. 2000-50 is obsolete. Section 5 of Notice 2024-12 clarifies Section 12 of Notice 2023-63 to reflect that Section 5 of Rev. Proc. 2000-50 is obsoleted only for expenditures paid or incurred in tax years beginning after December 31, 2021, and not for expenditures paid or incurred for tax years beginning on or before December 31, 2021.

Rev. Proc. 2024-9

On December 22, the IRS also released Rev. Proc. 2024-9, modifying Sections 7 and 19 of Rev. Proc. 2023-24 to provide procedures under Code Sec. 446 and Reg. Sec. 1.446-1(e) for obtaining automatic consent to change methods of accounting for expenditures paid or incurred in tax years beginning after December 31, 2021, in reliance on interim guidance under Code Secs. 174 and 460 provided in Notice 2023-63. Rev. Proc. 2024-9 also clarifies Section 9 of Rev. Proc. 2023-24 to provide that Section 5 of Rev. Proc. 2000-50 is obsoleted for costs of developing computer software paid or incurred in any tax year beginning after December 31, 2021, and continues to apply to costs of developing computer software paid or incurred in any tax year beginning on or before December 31, 2021.

For a discussion of the amortization of research or experimental expenditures for amounts incurred in tax years beginning after 2021, see Parker Tax ¶95,540.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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